Looming rate hikes seen dousing Canadian consumers, housing market

Looming rate hikes by the Bank of Canada will put financial stress on indebted Canadians and potentially exacerbate a slowdown in the nation's long housing boom, credit experts and real estate analysts said.

The central bank this week switched to a hawkish stance after years of ultra-low interest rates and just months after saying more rate cuts were possible, raising the specter of higher debt burdens on heavily leveraged households.

Canadian household debt has risen 51.5 percent since 2009, when the housing boom started, to C$2 trillion, and mortgages now account for about 66 percent of that, according to Statistics Canada. The debt-to-disposable income ratio is at a near-record 166.9 percent, meaning Canadians owe C$1.67 for every dollar of disposable income.

With consumers already so leveraged, a small increase in rates could force the most highly leveraged consumers to sell their homes.

"If we see a real slowdown in the housing market, individuals who bought in to a market that was very hot will have to unload their home at a reduced price and you're going to see significant financial issues in the market," said Laurie Campbell, chief executive at Credit Canada, a credit counseling agency that is funded by banks, retailers and other lenders.

The housing market has already begun to slow. Resales of Canadian homes dropped 6.2 percent in May from April, with Toronto sales plunging 25.3 percent, as new housing policy changes sideswiped demand.

An interest rate rise will hit big loans hardest, and then trickle down to other consumer credit.

"With a credit card, there is some flexibility - options for minimum payments - whereas with a mortgage the balance is big and you have to pay the whole amount every month, so it is a different story," said Regina Malina, senior director of decision insights at Equifax Canada, a credit agency.

Rate increases will hit real estate investors first.

"As soon as the mortgage payments go up a bit and the rent no longer covers the mortgage payment, people are going to try to unload those in a hurry. And that's part of what could trigger a mini crash in the condo market," said John Andrew, director of Queen's University Real Estate Roundtable.

Craig Wright, chief economist at the Royal Bank of Canada, said he expects rates to rise only gradually, slowing housing and auto sales.

"We borrowed a bit from the future so I would expect a cooling in housing as well as consumer more generally, including autos, partly because of rate increases but also because we brought forward activity and you get a bit of an air pocket after a while," Wright said.

David Macdonald, senior economist at the left-leaning Canadian Centre for Policy Alternatives, said economic growth is a bigger worry than loan defaults.

"Consumers retrench when they do not feel the wealth effect of ever increasing house prices," he said. "So instead of putting that money into the economy, you spend it paying down debt and you see a widespread economic impact ... it spirals."